Why the Fed, not the Middle East, is influencing oil prices

Oil Prices Extend Losses Due to Fed’s Impact

On Wednesday, May 22nd, the price of oil extended its losses with a drop of 1%.
For the third consecutive day, crude oil retreated due to expectations that the Federal Reserve might keep U.S.
interest rates higher for a longer period because of sustained inflation.
This could potentially impact fuel usage in the world’s largest consumer.

The actions of the U.S.
central bank and their direct consequences on consumption, economic growth, and the strength of the dollar are influencing oil prices.
Investors, who have been cautiously monitoring the Middle East, have noted that the impact of the Israel-Hamas war and internal Iranian affairs has been minimal so far.
The geopolitical risk on oil supply currently remains low.

Fed’s Influence on Oil Prices

The Federal Reserve is at the forefront of the oil sector’s attention and could impact crude oil prices with its future decisions.
The weakness in Brent and WTI prices, trading at $82 and approximately $78 per barrel respectively, with both experiencing a decline by 12:00 on May 22nd, is more attributable to the U.S.
than the Middle East.

First and foremost, the slide in oil prices came after reports of an increase in crude oil and gasoline inventories in the U.S.
last week, contrary to analysts’ expectations of a decrease, as cited from data by the American Petroleum Institute (API) on Tuesday.

Market Dynamics and Future Outlook

The physical oil markets have weakened, exemplified by the narrowing gap between the first-month Brent contract and the second month, known as Backwardation, which is nearing its lowest level since January.
When a market is in Backwardation (current prices exceed expected future prices), energy companies are more likely to withdraw oil from storage for immediate use rather than wait for prices to drop in the future.

Despite the relatively inconsequential impact of Middle Eastern dynamics, it is indeed the policies of the Federal Reserve that are predominantly shaping the oil market.
Consequently, investors are eagerly awaiting the minutes from the recent Fed policy meeting and the latest official data on U.S.
oil inventories provided by the Energy Information Administration (EIA) later on Wednesday.

Impact of Fed’s Decision on Oil

Lower interest rates would reduce financing costs for consumers and businesses, potentially stimulating economic growth and oil demand.
Conversely, higher financing costs could slow down economic growth and put pressure on oil demand.

Analysts from ANZ mentioned in a report that the FOMC minutes would be scrutinized in terms of the Fed’s assessment of first-quarter irregular inflation and clues on the timing and extent of potential interest rate cuts in 2024.

Any insights provided will also offer perspectives on oil prices.
At present, there do not seem to be any significant drivers from the Middle East for the oil sector.
The market appears increasingly immune to geopolitical developments, likely due to the substantial unused capacity within OPEC, according to Warren Patterson, head of commodity strategy at ING.